Wednesday, April 25, 2012

Challenge "Authority"

After a relatively long absence from these pages, (some 3 months), the urge to put thoughts down in writing, and to make of it a public exercise, has once again emerged.

A good part of the “blame” for this particular post can be squarely attributed to the revealing conclusions I drew recently from reading Robert Cialdini’s excellent book: “Influence”. In it, Professor Cialdini lays out a comprehensive set of systematic human traits / psychological principles, or perhaps more aptly described as flaws, which are inherently at odds with rational and optional decision making.

These flaws are many and varied but can be grouped under 6 categories:
  1. Commitment / Consistency (People have a desire to look consistent through their words, beliefs, attitudes and deeds)
  2. Social Proof (People often view a behavior as more correct in a given situation--to the degree that we see others performing it)
  3. Liking (People prefer to say yes to individuals they know and like)
  4. Reciprocity (This rule/psychological principle requires that one person try to repay what another person has provided)
  5. Scarcity (People assign more value to opportunities when they are less available)
  6. Authority (There is evidence of the strong pressure within our society for compliance when requested by an authority figure)
Although my intention today is not to delve deeper into these concepts as they relate to the field of investment decision making, I will, however, reflect on one of these categories: that of “Authority”.

Few places besides the capital markets and decisions around capital allocation lend themselves better to illustrate this particular concept at work. And just as importantly, in few areas of activity is unawareness of this human trait potentially more costly. In essence, authority, and our tendency as humans to be influenced by those exhibiting this quality, is often attributed to those that look, or talk as such.

Think how many of us automatically and without so much as a shadow of a doubt, defer important decisions to align with those in positions of authority. Just consider the impact on our investing choices of the latest opinion spouted by CNBC’s confident journalists or those people who brandish their impressive sounding job titles at such and such brokerage house / investment bank. By following the advice of these so called “experts”, we inadvertently shortcut the necessary consideration that our decisions should entail. We assume that “they know better” and act without consideration of an opinion’s true worth or even its motivation.

Given the mostly erratic nature of “expert” advice provided by these authorities, what should one do to break free from this natural deference to their words?

Professor Cialdini, quite wisely suggests that we step back and consider the source of this “authority”; that we should question whether it has been actually “earned”. After all, there are indeed authorities in every field and it would be unintelligent to ignore their valuable advice. However, true authorities should pass a fundamental 2-question test:

1. What is the basis for their expertise? / actual long-term investing track record? On the basis of this question only, you’d probably pay less attention to Jim Cramer and more to Warren Buffett

2. What is the motivation of these “authorities”?. For journalists, in 99% of the cases it is to entertain (hardly sound criteria to make money); for most sell-side analysts/investment strategists and various other financial experts: to sell their ware and brand, that is, to get exposure in the media for the firm they represent and to generate buying activity. (Again not a guaranteed source of consistent positive returns…)

As a way to break free from our natural respect for authorities, I put forward the following suggestions:

  • When confronted with an “expert” on TV or the press, think long and hard about the motive behind their words • Check the qualifications (in the broadest sense of the term) of those in apparent authority. A quick review of long term performance records is always worth one’s time
  • When given the opportunity, challenge the expert with questions concerning investing process. This alone will remove the element of historical luck as a basis for the authority’s status

In a market as turbulent as today’s where supposed “authorities” abound and yet wisdom is scarce, a heightened sense of skepticism will serve us well.

No comments:

Post a Comment